Best practices, updated every Wednesday

March 03, 2010

Risk collars: A great way to start offering alternative billing

Whenever I give speeches about alternative fees, lawyers who are just starting to consider this approach are fascinated by the idea of risk collars. These arrangements are essentially the same as hourly billing, with one giant exception: risk collars align the interests of lawyers and clients. If work goes over budget, both sides lose. And if it can be completed under budget, both sides win. This selection from our national survey of alternative fees provides some details.

Lawyers use the term "risk collar" to refer to an hourly billing arrangement built around an estimated budget for a particular matter. The client pays a bonus if work is completed under budget and/or gets a discount if the work goes over the budget.

Like a fee cap, this is really just a variation on hourly work, but unlike a fee cap it may align interests and offer incentives to both clients and law firms:

For people who are fearful about how big a risk they are taking on, I typically propose attempting to reach some accommodation on a collared arrangement. [Then] there are some limits to the upside, but there is also a limit on the risk [and] the downside for both the in-house and the outside counsel.

I think [risk collars are] helpful in situations where, because of the unknowns and the risks, both the lawyer and the client are a little bit tentative about venturing into the alternative fees waters.

If we bid two million dollars to do [a project, but] we come in at a million six, we get a percentage of that efficiency savings. That gives us an incentive to be efficient, because that’s gravy to us. It also means [that] clients don’t overpay.

Here are two examples from different firms:

Recently, we’ve offered incentive budgets to some clients for handling all their cases in certain areas. We represented one large financial services firm that had been sued in class actions across the US. About 3,000 people opted out, and some had formidable cases. We negotiated a fixed budget to handle all 3,000 cases. Both sides recognized that the cost of individual cases could vary wildly, so we negotiated a risk collar. If we exceeded the initial budget, we would discount our hourly rates on the overrun. If we could conclude all the cases below the original estimate, we would get a premium. We got the premium, and both sides benefited because our interests were aligned. It also helped the client substantially by providing predictable costs.

There is a situation with one of our large clients where there’s a portfolio of state court cases. We give them a budget for a year [where] we take everything into account. We keep them updated monthly [and] revise the budget quarterly. If we exceed the original budget, we get paid for the excess hours, but then we’ve got to write them a check back for 25% of what the excess hours were. If we do the work for less than the budget, they write us a check for 75% of the hours not spent.

The actual discounts and bonuses vary widely. See the complete report for a table with six examples of actual deals described by survey participants.